Pan American Silver — Refining estimates post Q2 results

PAAS’s Q223 results saw a significant step up in performance on the back of full consolidation of the recently acquired Yamana assets and a sequential increase in gold and silver prices. Total silver production was 6,024koz compared to just 3,891koz in Q123, while gold output was 248koz compared to 123koz in the preceding quarter. As a result, the company reported revenues of US$640m, up from US$390m in Q123, and adjusted EBITDA of US$218m, up from US$117m, at an improved margin of 34%. The results were affected by a number of one-off items, which included a US$32m inventory revaluation at the acquired mines, a US$42m pre-tax impairment charge related to the Morococha divestment and US$6m in transaction costs. Adjusted for these items EPS for the quarter came in at US$0.04. PAAS declared a dividend of US$0.10 per share, in line with Q123. During the conference call management commented that the company is working on an updated dividend policy, which it aims to introduce towards the end of the year.

While the headline results are not directly comparable with the preceding quarters, we note that both silver and gold segments reported a visible reduction in cash costs, with a 24% drop for the former and a 7% fall for the latter. Importantly, the Q2 cash costs were below the company’s quarterly guidance (see page 3). Improved cost performance came amid rather disappointing results from the company’s flagship La Colorada mine, which saw its mine EBITDA falling from US$10m in Q123 to a negative US$1.4m due to a reduction in processed tonnes and a consequent steep drop in silver output (related to persisting ventilation constraints in the high grade, dip zone of the mine). Among other factors that could have potentially affected the results is the company’s commitment (as part of the Yamana transaction) to deliver 20% of the silver produced by Cerro Moro (up to 1.2Moz pa until 7.0Moz achieved) for 30% of the silver spot price. Cerro Moro produced 1.4Moz of silver in Q2 and is guided to produce 3.6–3.9Moz in 9M FY23.

Net debt was reported at US$768m (US$726m including short-term investments) compared to US$776m in Q123 (US$674m). While net operating cash flow was up from US$51m to US$117m, free cash flow fell from US$13m to US$4m due to an increase in capex. H223 should see a significant improvement in the company’s liquidity position, following the recently announced divestment of the MARA, Morococha and Jeronimo projects as well as the sale of a number of non-controlling equity interests. The overall cash proceeds from these transactions are expected to reach US$593m, strengthening the balance sheet and reducing care and maintenance costs. We discussed these divestments in our recent note. With the announced sale of non-controlling assets and thanks to the anticipated improvement in operational performance in H2, we expect the company’s net debt to reduce to US$183m (including short-term investments) at end FY23.

As part of the results announcement PAAS provided an update on the ILO 169 consultation process at the Escobal mine. In Q223, three consultation meetings were held, during which the company and government institutions completed the information transfer to the Xinka indigenous people. Based on the public disclosure, it was expected that following the review of the provided information in August Xinka representatives would start the discussion of the potential issues with the Guatemalan Ministry of Energy and Mines. The Guatemalan Ministry of Energy and Mines expects the consultation process to be completed in October 2023. After this, the consultation will move into the final phase, which is Supreme Court verification, which should pave the way for the project to be restarted. We continue to model the restart in FY25, which we believe is a reasonable assumption allowing for the completion of the consultation process and the required preparations for the recommissioning of the project.

PAAS maintained its FY23 production and cost guidance, which it released with its Q1 results. The guidance takes into account the company’s pre-acquisition operations and a nine-month contribution from the Yamana assets. Total silver production is expected to reach 21–23Moz (6.7–7.7Moz from Yamana assets), while total gold production is guided at 870–970koz (405–465koz). As is typically the case for PAAS, production is expected to be second half weighted, with Q4 seen as the strongest quarter for both metals. Given the H1 results, the second half should bring a significant improvement in operational and financial performance.

We have updated our production, cost and financial estimates to reflect the Q2 results and more detailed information provided on the acquired Yamana assets. We have also slightly revised our FY23 gold and silver price assumptions to bring them closer to the year to date performance and current spot prices. Overall, our earnings estimates are little changed as we expect the company to generate US$741m in FY23 EBITDA (US$734m before), while our adjusted EPS estimate is virtually unchanged at US$0.36. The significant reduction in the reported EPS estimate is due to the higher D&A charge and one offs reported in H123. We note that our FY23 cost estimates for the silver segment are at the top end of the company’s guidance range as we take a more conservative view following the Q2 results and more specifically, the weaker than expected La Colorada performance. Also of note is an anticipated significant reduction in care and maintenance costs in FY24 following the disposal of MARA and Morococha.

Our EBITDA estimates compare to consensus of US$755m for FY23 and US$1,123m for FY24.

Our valuation approach for PAAS remains unchanged in that we continue to employ a discounted cash flow (DCF) methodology to value the company. However, following the release of the Q2 results we have reverted to using the conventional DCF methodology over the mine life for all the projects, including Yamana’s assets. These project level cash flows are combined into a single consolidated cash flow, which is discounted at a CAPM-derived WACC. Prior to that, our valuation was based on a sum-of-the-parts approach to capture the value of the Yamana assets post-acquisition. As shown in Exhibit 4, our updated valuation of the company after the Q2 results stands at US$22.2/share (from US$22.5).

In addition to the above-mentioned changes, we have updated our nominal WACC from 7.5% to 7.8% on the back of the higher risk-free rate (3.5% vs 3.1%) but lower equity risk premium (5.0% vs 5.9%; source: Damodaran). Our long-term real discount rate (post FY28) moves from 4.0% to 4.8% as we lowered our long-term inflation assumption from 3.5% to 3.0%. We have also reflected the recently announced sale of the non-core assets. Due to the lack of visibility on timing, we currently do not capture the value of the copper NSR royalties for MARA, which could represent a visible upside to our valuation given the potential scale of the project. As before, we model the restart of the Escobal project in FY25.

The peer group valuation of PAAS is complicated by the company’s increased scale and the lack of comparable medium-sized primary silver producers with a significant gold revenue stream. We have therefore subjectively put together separate peer groups for silver and gold companies. In addition to size, the analysis is distorted by different regional exposures of the broadly comparable companies.

On our revised estimates, PAAS trades on an EV/EBITDA multiple of 7.9x for FY23 and 5.4x for FY24 (based on Q223 net debt adjusted for the sale of non-core assets) versus the average multiple for the combined silver and gold universe of 13.5x for FY23e and 6.7x for FY24e. Applying an average peer group EV/EBITDA multiple for FY23/24e of 10.1x to our PAAS average FY23/24 EBITDA estimates implies a per share equity value of US$24.8.